This blog is a collection on my ramblings on Economics. I plan to write on current economic issues, recent research (sometimes mine, but more often others’), and issues of interest to economists. As I am writing from Turkey, I will try to focus more on the Turkish economy. While I will write in English, I will refer to articles in Turkish and might occasionally invite a guest blogger to write in Turkish. So, apologies for the semi-bilingual nature of the blog if you do not speak Turkish...

Friday, February 26, 2010

Mary Stokes, senior analyst for RGE covering CEEMA and author of many intelligent comments in this blog, sent me some yet more comments on Balkan contagion- I am only quoting some of her comments, as she said she preferred to be quoted only on the countries she covers, but she made a couple of interesting comments on the developed countries as well:

I just quickly read through your post and it was a very nice read. I really like your point on global risk appetite and I think you make it strongly and simply: "While looking at simple correlations hints of a contagion effect from the eve of the Greek crisis late in the year onwards, the relationship disappears once you control for global risk appetite, as proxied by VIX- a measure of the implied volatility of US stock options, often touted as the markets' fear gauge."

My only slight quibble would be the take on Romania. I think the Vienna Initiative is a very positive thing. See my old post here: http://www.roubini.com/analysis/56666.php

However, there is no actual enforcement mechanism so while I think the Vienna Initiative is an important step that minimizes the risk of a bank pullout, I don't think it completely eliminates the possibility. So I agree with your fundamental statement, but with that slight caveat: " The Vienna initiative, which entails rollover and recapitalization commitments from parent banks to their subsidiaries in five countries with IMF-supported programs, provides some cushion for Romania."

This is more of an aside on Romania:While Romania has the current EU/IMF program, if politics continues as usual, Romania could again face troubles meeting its IMF loan conditions and face another freeze in disbursements. The same political players involved in the recent crisis are still in power and do not seem to have changed their tunes even in the face of crisis. (See: http://www.roubini.com/euro-monitor/258281/imf_loan_programs_in_europe_run_into_political_obstacles) Nevertheless, the IMF could show considerable flexibility and continue lending even if Romania misses targets/conditions.

In addition, she and her colleague look at the same topic, but not just for the Balkans, at a recent Economonitor post. You'll see that they refer to a small empirical study I conducted, which is barely mentioned in the Hurriyet and Forbes pieces. Mary saw an early draft, where I was eloborating more on what I did. Let me quote directly from that draft:

But such concerns seem to be limited for now, not just for Turkey, but for the region as a whole. To show that, you can look at the link between Greek credit default swaps (CDS), which insure against default, and those of Bulgaria, Romania and Turkey.

While looking at simple correlations hints of a contagion effect from the eve of the Greek crisis late in the year onwards, the relationship disappears once you control for global risk appetite, as proxied by VIX- a measure of the implied volatility of US stock options, often touted as the markets' fear gauge. The effects are tiny for all three, but Turkey seems to be even less affected by the Greek crisis than Bulgaria and Romania. Repeating the same exercise with equities reveals a similar conclusion.

All this is to say that markets in the Balkans are responding more to global risk appetite than to regional concerns for now, especially for Turkey. Nonetheless, there are valid reasons to be cautious, particularly if fiscal concerns were to spread to the major developed economies.

Such a fiscal feeding frenzy would not only start another bout of risk aversion, but could also bring the hidden fiscal agenda of the Balkans back to the table. Then, the foster-child could find itself in the orphanage.

If you want more details, I was just doing rolling regressions: Regressing CDS of each country on CDS of Greece + risk appetite, as proxied by VIX. The point was that once you put VIX in, the Greece CDS coefficient, large and significant before, almost disappears.